Always true, nowadays obvious
Timeless lessons are better appreciated in tumultuous times
Uncertainty is back, although it never really left. So is moronic, cruel policy that shouldn’t.
If you’re one of those “Lockdown inevitable ya” elites, you are volunteered to explain to slum kids why, after depriving them of education for a year, you support depriving their family of food for a month. I know you prefer Zoom, but they can’t. Once done, you can revert to your UV-lit, sanitized, gated existence, Whatsapping about privilege. Don’t bother reading ahead, as sanctimonious hypocrisy and sound judgment don’t go together.
Boy, that rant felt good. Now, where was I? A year ago, I used uncertain times as an excuse to highlight a few permanent truths about our messy world. Now felt a good time to re-hash them (before I return to writing fresh essays on investing, after a month’s break).
Decades back, my MS thesis involved studying latent damage in semiconductors by applying electrical stress. This engineering notion of stress testing to reveal the true nature of things is applicable in a more general sense. In our messy world, without the ability to run controlled experiments, we have to make do with real world stress to better understand problems that are omnipresent yet unseen. In this spirit, it’s worth revisiting a few eternal truths that are more apparent after March Madness than before.
I hate that acronym. Not because it’s wrong. Because its use tends to spike only after it’s too late. World is VUCA in the same sense that water is wet. I view the world as ridiculously messy at all times, way more so than this acronym implies. It’s unknowable, uncontrollable and un-modellable. Flawed humans know sh*t but pretend otherwise. We can’t even explain the past, let alone predict the future. A lot of nonsense – forecasts, forward earnings, DCF, guidance, op-ed columnists, Tweeting heads – would become superfluous if we defaulted to this worldview. Our emphasis would be on getting into stronger boats than on predicting the seas. Ironically, when VUCA usage is at its peak, risk tends to be lower. Trick question: Is the world, in investing and in general, more risky this January or right now?
At business school, I was taught gibberish around optimizing capital structure using debt. I struggled with decimal-point accuracy in levered and unlevered betas. In contrast, the finest promoters I’ve known think of an optimal balance sheet as one that lets them sleep well at night. This entails retaining a quantum of surplus cash that appears indefensible in ‘normal’ times. Having lived through a set of shocks, this promoter view makes way more sense than the academic view. As a co-owner in a business, I’d rather have the primary owner dealing with the real-world shock than worrying about where scarce money would come from. Empirically, safer companies tend to emerge stronger than ‘optimized’ ones, after every shock. There’s something incongruous about a bunch of people with lifelong job security in a contrived setting lecturing the world about risk.
In investing, not owning a single financial-services business beats showing up naked, in terms of being seen as a freakish weirdo. I quickly clarify that I am not entirely averse to the former and I have not (yet) attempted the latter. When the default setting is towards companies with high return-on-capital and zero debt, financial services isn’t a natural fit. Add complexity, opacity, accounting-ambiguity and incentive-distortions to a highly-leveraged commodity business, and picture gets murkier. This is a lonely view as such businesses have been viewed as must-have toys. Everyone just had to get themselves a lending business – PE, buy-out, hedgie, even VC, brokers, investment bankers, conglomerates, anonymous Canadians. Despite blow-ups in a plethora of segments (e.g. micro-fin, gold loan, infra finance, personal loans, corporate loans), lenders remained popular. Often, PB multiples looked like PE multiples. Over the past year or so, there is a belated realization of latent risks in such OPM businesses. What I’ve outlined isn’t an India-specific problem. Across countries, a majority of lenders aren’t competent, trustworthy, special or safe. Only a rare few keep their head when all about them are losing theirs. If history is a guide, recent lessons on this front will be entirely forgotten in a few years with a new set of lenders, giving away money faster than Bill Gates, becoming fashionable.
Need for a pole star
Stock markets are an extreme manifestation of our messy world. I’ve called them maddening and that currently feels like an understatement. To not get lost or go insane in such stormy seas, we need our own pole star. In technical terms, an independent focal point that has nothing to do with stock markets. To me, that pole star is a mindset of owning businesses as opposed to buying stocks. This keeps the mind focused on business matters over squiggly lines. It forces questions of which businesses are worth owning at all, and only for those, what they’re roughly worth. Ideally, I can look at businesses as if they are privately-owned without a stock ticker. Stock price enters the picture only on the rare occasion when it’s facilitates such ownership at sensible terms. Rest of the time, it’s a mind-numbing fantasy sport thingy that’s best consumed in very small doses.
Temperament is everything
Having a pole star doesn’t imply smooth sailing. Most say the same trite stuff about owning good businesses at fair prices. At the least, no one admits to the opposite. The slip between words and action is entirely psychological in nature, as this fantasy-sport thingy seriously messes up the mind. When Swiggy offers me 50% discount on a slice of Chocolate Truffle Cake from Theobroma, I don’t think any worse of that delicious goodness. I salivate unconditionally. When a publicly-listed goodness falls from 100 to 50, I am wracked with doubt despite having waited years for exactly this. Doubt about goodness. Doubt on whether I’ll get a stomach upset. Self-doubt. Doubt that those who marked it down know something I don’t. While I am more happy than sad at the good deal, my joy isn’t unconditional or unambiguous despite years of preparation. I nibble, hesitantly and fearfully. Then, it gets worse. Having bought a few at 50, price falls to 25. Instead of rushing to fill my fridge, I lose appetite. Even the one that I just savoured no longer sits well in my tummy. Weak spirits may even throw up. To profit from progressively better deals in a stomach-churning environment, the gating factor is temperament, not intellect. After March Madness, etymology of the word ‘guts’ makes complete sense.
Originally published in March 2020 at https://www.linkedin.com/pulse/always-true-nowadays-obvious-anand-sridharan/